Financial Management and Business Data Analytics · Cash Flow Statement - Preparation and Analysis

Cash Flow Statement Basics: AS 3 and Ind AS 7

Updated 10 October 2026 · Fact-checked

A cash flow statement reports the inflows and outflows of cash and cash equivalents of an enterprise during a period, classified into operating, investing and financing activities. AS 3 (and Ind AS 7 for companies following Ind AS) prescribes its format and disclosures. To answer questions, first identify cash items, then classify each flow.

Understand Cash Flow Statement Basics and AS 3 / Ind AS 7

Profit is not cash. A business can show a profit and still run short of money because customers have not paid, stock has been bought, or loans are due. The cash flow statement fills this gap. It shows where cash came from and where it went during the period.

The statement explains the change in cash and cash equivalents between the opening and closing balance sheet. It does this by splitting all flows into three groups: operating, investing and financing activities. The total of the three, added to the opening balance, gives the closing balance.

Cash means cash in hand and demand deposits with banks. Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and carry an insignificant risk of change in value. An investment normally qualifies only when it has a short maturity, usually three months or less from the date of acquisition. Examples: treasury bills, commercial paper and money market mutual fund units bought close to maturity. Equity shares are not cash equivalents. Bank overdrafts repayable on demand that form part of cash management may be included in cash and cash equivalents as a negative component.

The objectives are to show the cash generated and used, to help assess liquidity and solvency, to show the ability to pay debts and dividends, and to help forecast future cash flows. Benefits include a better view of liquidity than profit gives, comparison across firms, and help in planning. Limitations are that it uses historical data, ignores non-cash transactions, can be affected by timing of payments, and does not replace the income statement. It also does not show profitability.

AS 3 applies to enterprises under Indian GAAP. Ind AS 7 applies to companies following Ind AS. Both use the same three-way classification and allow the direct or indirect method for operating activities. Know the differences listed in the formulas section, as examiners ask for them.

Key rules to remember

Core cash flow equation: Net change in cash = Operating CF + Investing CF + Financing CF; Add the net change to opening cash and cash equivalents to get the closing balance.
Closing balance: Closing cash and cash equivalents = Opening balance + Net increase (or − Net decrease); This must agree with the balance sheet figure for cash and cash equivalents.
Cash equivalent test: Short-term + highly liquid + known amount of cash + insignificant risk of value change; Normally original maturity of three months or less from the date of acquisition. All conditions must hold.
Three activity classes: Operating = main revenue-producing activities; Investing = long-term assets and investments; Financing = owner capital and borrowings; Classify by the nature of the activity, not by the balance sheet label alone.
Direct vs indirect method: Direct: gross receipts − gross payments. Indirect: Net profit before tax adjusted for non-cash and non-operating items and working capital changes; Both give the same operating cash flow. Investing and financing sections are the same either way.
AS 3 vs Ind AS 7: interest and dividend: AS 3 (non-financial enterprises): interest paid and dividends paid = financing; interest and dividends received = investing. Ind AS 7: interest and dividends paid may be operating or financing; interest and dividends received may be operating or investing; the choice is applied consistently; Financial enterprises can treat interest and dividends as operating under both standards. Always check which standard the question names, and verify the wording against the standard.
AS 3 vs Ind AS 7: other points: Ind AS 7 requires disclosure of changes in liabilities arising from financing activities; AS 3 has no such requirement. Ind AS 7 also covers other disclosures such as cash flows of subsidiaries obtained or lost. Cite only points you are sure of.

How to solve Cash Flow Statement Basics and AS 3 / Ind AS 7 questions

Use this method for theory questions and for short numerical questions on the basics of the statement.

1Read the question and note which standard it names: AS 3 or Ind AS 7. This changes the treatment of interest and dividends.
2For a definition question, write the meaning first, then the standard's definition of cash and cash equivalents.
3For a classification question, ask: is this the main revenue activity, a long-term asset or investment, or capital and borrowing? That decides operating, investing or financing.
4For a cash equivalent question, test the investment on all conditions: short term, highly liquid, known amount, insignificant risk, maturity of three months or less at acquisition.
5Mark non-cash items separately: depreciation, provisions, and transactions like shares issued for assets. They are not cash flows.
6For a difference question, write a two-column comparison with at least four points and name the standard in each column.
7State the closing check: opening cash plus net change equals closing cash.

Quickest way: Three-bucket classification

When to use it: Use it when an MCQ asks which section a transaction belongs to or whether an item is a cash equivalent.

Ask first: did cash actually move? If not, ignore it.
Sale of goods, payment to suppliers, wages, tax: operating.
Purchase or sale of fixed assets and investments, loans given: investing.
Shares, debentures, loans taken, repayments: financing.
For interest and dividends, check the standard and whether the entity is a financial enterprise.
For cash equivalents, check the three-month rule at the date of acquisition, not the date of the balance sheet.

Common mistakes in Cash Flow Statement Basics and AS 3 / Ind AS 7

Treating profit or depreciation as a cash flow
Students link the statement to the profit and loss account.
Fix: Remember that depreciation is a non-cash charge. It is added back only in the indirect method, and only to reach cash from operations.
Calling any short-term investment a cash equivalent
The word short-term feels enough.
Fix: Apply all tests, including the three-month maturity from acquisition. An investment bought with one year to maturity is not a cash equivalent even if it matures soon.
Classifying interest and dividends the same way under both standards
Students memorise one rule.
Fix: Under AS 3 a non-financial enterprise shows interest paid and dividends paid as financing, and interest and dividends received as investing. Under Ind AS 7, interest and dividends paid may be operating or financing, and those received may be operating or investing, applied consistently.
Including non-cash transactions in the statement
Shares issued for machinery look like investing and financing.
Fix: Exclude them from the flows and disclose them separately, since no cash moved.
Writing limitations that confuse the statement with the profit and loss account
Students say it does not show profit, as if it were a fault.
Fix: Give limitations such as historical nature, ignoring non-cash items, timing effects and the fact that it must be read with other statements.

Worked examples

Example 1

State the meaning of cash and cash equivalents under AS 3 / Ind AS 7. Which of these is a cash equivalent? (a) Treasury bill bought on 1 March 2027 maturing 30 April 2027 (b) Equity shares of a listed company (c) Fixed deposit of 18 months with a bank, bought on 1 Feb 2027 (d) Cash at bank in a current account.

Show the solution

Cash is cash in hand and demand deposits with banks.
Cash equivalents are short-term, highly liquid investments readily convertible into known amounts of cash, with insignificant risk of change in value, normally with maturity of three months or less from acquisition.
(a) Treasury bill: bought 1 March, matures 30 April, about two months. Highly liquid and low risk. It is a cash equivalent.
(b) Equity shares: value changes and there is no known amount. Not a cash equivalent.
(c) 18-month deposit: maturity far exceeds three months. Not a cash equivalent.
(d) Current account balance is a demand deposit, so it is cash itself.

Answer: (a) is a cash equivalent and (d) is cash. Together they form cash and cash equivalents. (b) and (c) are excluded.

Example 2

Classify the following cash flows for a manufacturing company under AS 3 and say which are not cash flows: (i) Cash received from customers ₹8,00,000 (ii) Purchase of machinery for cash ₹3,00,000 (iii) Issue of equity shares for cash ₹5,00,000 (iv) Depreciation charged ₹60,000 (v) Interest paid ₹40,000 (vi) Dividend received ₹10,000.

Show the solution

(i) Receipts from customers come from the main revenue activity: operating inflow ₹8,00,000.
(ii) Purchase of machinery is a long-term asset: investing outflow ₹3,00,000.
(iii) Issue of equity shares raises owner capital: financing inflow ₹5,00,000.
(iv) Depreciation involves no cash movement. It is not a cash flow.
(v) Under AS 3 a non-financial enterprise shows interest paid as financing: outflow ₹40,000.
(vi) Under AS 3 dividend received is investing: inflow ₹10,000.
Summary: investing = −3,00,000 + 10,000 = −2,90,000. Financing = +5,00,000 − 40,000 = +4,60,000. Operating = ₹8,00,000, which is only the receipt given. No operating payments are given, so this is not a complete operating cash flow.

Answer: Operating inflow ₹8,00,000 (the only operating item given, with no operating payments provided); investing net outflow ₹2,90,000; financing net inflow ₹4,60,000; depreciation is not a cash flow. Under Ind AS 7, interest paid could instead go to operating and dividend received to operating, if applied consistently.

Exam tips

Expect MCQs on cash equivalents, classification of one item, or the standard-specific treatment of interest and dividends. Read the standard named in the question.
In theory answers, give points in short bullets with a heading for each: meaning, objectives, benefits, limitations. This earns step marks.
When asked for AS 3 vs Ind AS 7 differences, write a two-column comparison and keep only points you are sure of.
Write the closing check, opening cash plus net change equals closing cash, in numerical answers.
There is no negative marking in the MCQ section, so attempt every question.

Practice questions from Cash Flow Statement - Preparation and Analysis

Cash Flow Statement Basics and AS 3 / Ind AS 7 in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Cash Flow Statement Basics and AS 3 / Ind AS 7: frequently asked questions

What is a cash flow statement in simple words?

It is a statement showing how much cash came into and went out of a business during a period. It explains the change in cash and cash equivalents through operating, investing and financing activities.

What are examples of cash equivalents?

Treasury bills, commercial paper and money market fund units bought with a maturity of three months or less are common examples. Equity shares and long deposits are not cash equivalents.

Is a cash flow statement mandatory?

AS 3 and Ind AS 7 prescribe how it is prepared. Whether a particular entity must present it depends on the Companies Act and the applicable accounting framework. Check the entity type given in the question.

What are the main limitations of a cash flow statement?

It is based on past data, it ignores non-cash transactions, and timing of payments can distort it. It also does not show profitability, so it must be read with the balance sheet and profit and loss account.

Which method should I use for operating activities?

Both the direct and indirect methods are permitted and give the same operating cash flow. Use the one the question asks for. If the choice is open, the indirect method is usually quicker from financial statements.